What is a recession?

Time to clarify common misconceptions of the official definition

WASHINGTON (MarketWatch) -- As investors and policy-makers puzzle over the threat of a recession, it's time once again to revisit how a recession is defined.

As a way to keep politics out of it, by convention, U.S. recessions are determined by a committee of academic economists who belong to the National Bureau of Economic Research, which, despite its official sounding name, has no link to the government.

Martin Feldstein is the president of the group. He and Ben Bernanke were on the business-cycle-dating committee that determined the beginning of the 2001 recession. Bernanke had left to join the Fed by the time the committee determined the end of the recession.

Many people have heard that a recession is marked by two consecutive quarters of negative growth, as measured by gross domestic product. That description is close, but not quite accurate.

The official definition comes from the NBER: "A recession is a significant decline in economic activity spread across the economy, lasting more than a few months." Or in the words of business cycle forecaster Lakshman Achuthan of the Economic Cycle Research Institute: A recession is a "pronounced, pervasive and prolonged" slowdown in the economy. Pronounced means deep, pervasive means wide and prolonged means long.

Another common definition of a recession goes something like this: A recession is when you don't have a job; a depression is when I don't have one.

It's not surprising that the NBER uses employment as one of major business cycle indicators. Employment is a major sign of economic health. When jobs are plentiful, most families enjoy a rising standard of living. But when the unemployment rate rises, anxiety mounts even for those who retain their jobs.

The employment picture has worsened. Payrolls fell in August, the first decline in four years. Looking at the longer trend, payrolls are growing at the slowest pace in about three years, and the unemployment rate has risen to 4.6% in August from 4.4% in March. Even with the slowdown, payrolls are 1.2% higher over the past year, slightly slower growth than the 1.3% increase in the adult population.

Industrial production is the other major indicator NBER uses to gauge whether the economy is expanding or not.

The manufacturing sector, while not as large as it once was, is still attuned to the business cycle. Many companies or individuals won't buy long-lasting durable goods when they are unsure of the future.

But because of improved inventory techniques and productivity gains in manufacturing, the business cycle doesn't affect manufacturing nearly as much as it used to. In the 1975 recession, for example, industrial output fell 12.8% from peak to trough, while in the 2001 recession, output dropped just 6.3%.

In the past year, output has grown 1.4%, only half the growth rate seen as recently as February. Just like with employment, industrial production is growing, but at a much slower rate.

Economist Edward Leamer of UCLA argues that the U.S. will avoid a recession this time because there aren't enough superfluous workers left in the manufacturing sector to be laid off. Typically during a recession, manufacturing employment plunges, then recovers most of the loss. After the 2001 recession, however, manufacturing employment fell and never recovered.

Personal incomes are up 4.4% in the past year after adjusting for inflation, and have actually accelerated in recent months after dipping in the spring when gas prices sent inflation through the roof.

Incomes were decelerating sharply well ahead of the 1990 and 2001 recessions. The strong growth in incomes this year is one reason many economists believe consumer spending won't falter if even home prices continue to fall, and that will keep the economy out of recession.

Real business sales faltered earlier in the year, but have bounced back on strong sales at the wholesale and retail levels. Total sales are up 1.2% in the past year.

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